Singapore Company’s Functional Currency
Companies operating internationally often deal with multiple currencies. Choosing the right currency to report financial results may seem like an accounting detail, but it actually affects how profits, costs, and performance are understood. This guide explains functional currency, why it matters, and how it differs from the currency you present your results in.
-
What is Functional Currency?
FRS 21 The Effects of Changes in Foreign Exchange Rates defines functional currency as the primary currency in which a business conducts its day-to-day operations. In practice, it is the currency that best reflects the economic environment in which the company earns and spends cash.
Examples:
-
A local retailer in Singapore that buys and sells almost exclusively in SGD will naturally have the SGD as its functional currency.
-
Conversely, a Singapore-based company that earns most of its revenue in USD and pays suppliers in USD may have the USD as its functional currency, even though it is incorporated in Singapore.
|
-
Why Is Functional Currency Important?
Functional currency determines how a business’s financial performance is measured and presented. A Singapore-incorporated company that earns most of its revenue in USD should reflect that reality by using USD as its functional currency. Reporting in SGD instead can make profits appear higher or lower simply because of exchange rate movements, rather than changes in actual business performance.
Choosing the appropriate functional currency supports:
-
Financial reporting accuracy: Ensures that revenues, expenses, and profits are not distorted by currency fluctuations.
-
Regulatory compliance: Accounting standards FRS 21 require companies to determine and disclose their functional currency based on their economic environment.
|
-
How Do We Determine Functional Currency?
FRS 21 provide guidance on how to decide a company’s functional currency.
|
Category
|
Indicator
|
Example
|
|
Primary Economic
Environment
|
Currency that mainly
influences sales prices
|
The currency that
drives revenue. E.g., 70% of sales in USD → USD is primary.
|
|
Currency of the
country whose competitive forces & regulations mainly determine sales
prices
|
Local market pricing
rules. E.g., a retailer in Singapore → SGD.
|
|
Other Indicators
|
Currency that mainly
influences labor, material, and other costs
|
Salary, rent, and
production costs. E.g., costs in MYR → MYR.
|
|
Currency in which
receipts from operating activities are retained
|
Cash held in local
bank accounts. E.g., MYR bank accounts → MYR.
|
|
Financing &
Intercompany Transactions
|
Currency in which
funds from financing activities are generated
|
Loans or capital
raised. E.g., USD loans from parent company → USD.
|
|
Currency in which
receipts from debt or equity instruments are denominated
|
Bonds or shares
issued. E.g., USD bond → USD.
|
Key idea: The most important factors are usually sales/revenue and major operating costs. Financing and other indicators help confirm the choice.
-
Functional vs. Presentation Currency
It’s important to understand the difference between functional and presentation currency.
-
Functional Currency: The money a business actually uses in its day-to-day operations—the currency that reflects how it earns revenue and pays costs.
-
Presentation Currency: The currency in which a company chooses to show its financial results to investors or other stakeholders.
|
For example, a company might operate mostly in USD (its functional currency) but present its consolidated financial statements in SGD so that local investors can easily understand the numbers. When presentation and functional currency differ, conversion can create apparent gains or losses due to exchange rate changes - even if the business itself hasn’t changed.
-
Changing Functional Currency
A company’s functional currency can change if there is a significant shift in its economic environment - such as relocating operations, changing primary markets, or altering the source of financing. However, such changes are rare and must be justified with clear evidence.
Conversion rules:
-
Balance Sheet items: Use the exchange rate at the reporting date.
-
Non-monetary items (e.g., PPE, Share): Use historical rates.
-
Profit and Loss items: Use average rates for each month.
|
Key point: When a functional currency changes, the change is prospective - it only applies from the date of change onward. Past financial statements are not restated.
-
Quick Example: If a Singapore-based e-commerce company earns 70% of its revenue in USD, 20% in EUR, and 10% in SGD, but pays most of its local operating costs in SGD, which currency is most likely its functional currency and why?
Answer: USD!
The primary factor for functional currency is the currency that mainly influences sales prices and revenue. As 70% of revenue is denominated in USD, this strongly indicates that USD is the functional currency. However, other indicators said operating costs are mostly in SGD. Well, other indicators only guide if the primary indicator is inconclusive. In this case, revenue dominance (70% USD) is clear, so USD still takes priority.
Conclusion
Functional currency is more than an accounting requirement - it reflects how a business actually operates. Choosing the right functional currency ensures financial results accurately show profits, costs, and cash flows, helping management and investors make informed decisions.
KNOWLEDGE
